6.6 The owner states that there is little competition at present for his business. This might suggest that the business was a monopoly. A monopoly is, technically, a situation in which there is only one supplier, but this is very rare, and the legal definition is that one firm has control of at least 25% of the market. However, this is not the case with A.W. Thompson as it is a small business and provides a service for a small niche market. It could therefore be said that there are few competitive threats. However, by turning down the work in Edinburgh, the business will force Unite to look for an alternative replacement which they could then use in the future as well.
7. Accounts
7.1 The accepting of the new job will have an effect upon the firm’s financial position. In order to gain an up to date and relevant representation of the current financial position of the firm, analysis of the firm’s accounts will be conducted. This can be extended to a forecast of the impact of rejecting or accepting the additional job. It may be that even rejection while operating at full capacity will have a detrimental effect upon the financial position.
7.2 Cash Flow
For many small firms cash flow/liquidity is as important as profit (see 7.3. below). An analysis of the impact of the accepting/rejecting the offer upon cash flow is conducted below. The Ratio Analysis (see 8. below) assesses the current liquidity position, and provides an indication of whether liquidity is of significance for the firm. From 8. below it appears that usually the firm is reasonably liquid. However, as can be seen from the two cash flows expenditure upon the additional materials to undertake the job initially has a detrimental effect upon the firm’s cash flow. This, nevertheless is only temporary and the final effect is beneficial.
Cash flow forecast without additional job
Cash flow forecast including additional job
It can be seen therefore that by taking on the additional job the firm may experience cash-flow difficulties in the short run with the net cash flow of -£7,100, in the long run the business will benefit by an estimated £61,372.50. This is further illustrated on the graph below.
7.3 Profit vs. Cash
7.3.1 A careful assessment of the availability of liquid assets is essential for the smooth running of any business. With cash planning or budgeting, the flows of cash into and out of a firm’s bank account has been forecast, so that any excess of payments over receipts can be highlighted and action taken to overcome it in the short-run.
7.3.2 Any profitable business has the potential to become insolvent if its cash is not managed effectively using a cash flow forecast. There are several reasons why the profit or loss recorded by a business in one time period will not be the same as its cash balance. These include:
- A business may be selling more of its output on credit than in previous years. Therefore, a profit is being made as the goods are being recorded as sold, but the cash payment from customers will be received at some time in the future. This period of credit may leave the firm dangerously short of cash and liquid funds.
- Capital expenditure is recorded on the profit and loss account under depreciation as an expense. However, only a proportion of the cost of additional capital spending will be recorded as depreciation each year, yet the total cash payment may occur in the first year.
7.3.3 It can be seen from the cash flow forecasts including and not including the estimated costs and receipts from the additional job that A.W. Thompson will benefit in the long run. However, in the short run, it will create a cash deficit, as expenditure is greater than receipts. Although, this may be a deterrent for other small firms for taking on the additional job, A.W. Thompson has a strong acid test ratio of 1.27 (see 9. below). This means for every £1.00 of current liabilities, A.W. Thompson has £1.27 of current assets. The business can therefore afford to take on the job and it will not in turn cause great cash-flow difficulties.
7.4 The Balance Sheet
The estimated value of goodwill at £50,000 should normally feature on a balance sheet just after it has been purchased for more than its assets are worth, or when the business is being prepared for sale. Disputes can arise between accountants about the valuation of intangible assets and this is why there was no value on the balance sheet in A.W. Thompson’s accounts. However, the firm’s accountants (who have a wealth of experience with small firms) were consulted and the value of £50,000 was considered to be appropriate due to the current strong business relationship which exists between A. W. Thompson and UNITE, a market leader.
Balance Sheet as at 30th January 2002
Balance Sheet as at 30th January 2002 amended to include the estimated value of goodwill.
As can be seen the value of the firm is 2.09 times the size previously thought by the owner. This is significant since if this is lost if the offer is rejected then the firm’s value would more than half. Also, if the goodwill was lost then further sales might be lost too as UNITE might establish a similar relationship with an other firm.
8. Ratio Analysis
Profit and loss account for the year starting 1st November 2000 to 31st October 2001
A ratio analysis has been carried out to:
- Assess the firm’s financial position and current performance. This is a form of secondary research.
Accountants make comparisons of accounts by relating two accounting results to each other in the form of a ratio. These ratios are grouped into five more classifications-:
- Liquidity ratios –these give a measure of how easily a business could meet its short-term debts or liabilities.
- Profitability ratios – these compare the profits of the business with sales, assets, and the capital employed in the business.
- Efficiency ratios – these give an indication of how efficiently a business is using their resources and collecting its debts.
- Shareholder ratios – these can be used by existing potential shareholders to assess the rate of return on shares and the prospects for their investment.
- Gearing ratio – this examines the degree to which the business is relying on long-term loans to finance its operations. It is a reflection of a business’s financial strategy.
- Net profit margin
= 35,000 x 100
450,000
= 7.8%
This appears to be a low figure which indicates the relatively high turnover to the relatively low profit. However, for the majority of small retail and industrial firms, the annual profit to sales ratio is roughly from 2 to 5% (source: Charlton & George, accountants). It should be remembered that it would be more accurate by monthly calculations as particularly with A.W. Thompson, due to the nature of seasonal demand, there would be high month to month net profit margin fluctuations.
- Gross profit margin
This ratio compared gross profit (profit before deductions of overheads) with sales turnover). The formula used is:
The gross profit margin for A.W. Thompson is therefore
= £75,000 x 100
£450,000
= 16.67%
This indicates that the average mark-up on cost of sales to each job is approximately 17%.
To increase this ratio, A.W. Thompson would have to either reduce the cost of sales while maintaining revenue, or by increasing revenue without increasing the cost of sales e.g. by increasing the mark-up.
- Return on capital employed
This is commonly used to assess the profitability of a business. It compares profit with the capital which has been invested in the business.
A.W. Thompson’s return on capital employed is therefore,
£35,000 x 100 = 76%
£46,000
8.4 Liquidity ratios
The liquidity refers to the ability of a firm to convert its short-run or current assets into cash to cover payments as and when they arise. Stocks are the least liquid of the current assets because they must be sold (most likely on credit). As a result, there is a time lapse before stocks are converted to cash. It is the responsibility of the business to ensure that it can meet debts likely to arise in the near future. Current liabilities are items that have to be paid in the short-run.
= 76,000
60,000
= 1.27
This figure shows that for every £1.00 of current liabilities, there is £1.27 of current assets. This figure therefore shows the business is in a fairly good position, as it means the firm can pay its short term debts, 1.27 times with its current assets.
However, some might argue that stock gives an overconfidence of current assets, as there is no guarantee, they could be definitely sold when necessary. Therefore the acid test should be used. The acid test is a tighter measure and is a ratio of
Acid test = 76,000
60,000
= 1.27
As this figure is the same for the liquidity ratio, it shows the business is in a safe financial position. Accountants usually look for an acid test ratio of 1:1. This figure shows that for every £1.00 of current liabilities, A.W. Thompson has £1.27 of liquid current assets.
- Debtor days ratio
This is also known as the debtors’ collection period. It measures how long on average, it takes businesses to recover payment from customers who have brought the goods or service on credit – the debtors.
Therefore the debtors day ratio for A.W. Thompson =
£6,000 x 365 = 5 days
£450,000
This shows that although the majority of jobs are carried out on a credit agreement, the control of debtors and payment periods is good. This means that although A.W. Thompson does not lose sales by not allowing sale by credit, it also is able to continue managing its working capital.
9.6 Ratio analysis are widely used by company analysts and prospective investors before making assessments and taking important decisions on:
- Whether to invest in the business
- Whether to lend the firm money
- Whether the profitability is rising or falling
- Whether the management are using resources efficiently
In this case they have shown:
- That A.W. Thompson are in a healthy financial position as the owner himself suggested.
- That their liquidity position is healthy. This would lessen the risk of accepting the new order.
- That the management appears to be managing resources efficiently, indicating a good level of competence. This suggests that dealing with the additional job would be within the ability of the current management.
10. The size of the business
10.1 There are many definitions of the term ‘small business.’ The first significant attempt to assess the small business sector was made under the chairmanship of J.E Bolton. In 1971, the Bolton Report was published. The report indicated that a small business has three essential characteristics:
- It is managed by its owner(s) in a very personalised way.
- In economic terms it has a relatively small share of the market.
- The owner is free from outside control in his or her principal decisions and the business is independent in that it does not form any part of a larger enterprise.
10.2 The Bolton Report also provided more specific measures of a ‘small business’ based upon the type of industry in which the business operates. The construction industry must have 25 employees or less.
10.3 All the above apply to A.W. Thompson, and it can therefore be classified as a small business.
10.4 Economic theory suggests that large firms should be more efficient than small firms due to the existence of economies of scale.
10.5 Despite this small firms including A.W. Thompson continue to survive for the following reasons.
- Small businesses can supply a small niche market. For example the niche market of supplying and installing relocatable partitioning systems, dry-lining, and suspendable ceilings.
- They can provide a personal or more flexible service. For example, A.W.Thompson has established a high degree of brand loyalty with a larger contractor.
- The owner can often gain a high degree of self-fulfilment from their work and are therefore often highly dedicated.
10.6 However, there are also reasons why A.W.Thompson, like other small businesses might wish to grow. After all, growth is one of the three prime organisational objectives.
- Cost saving – firms can benefit from economies of scale, and reduced actual fixed costs
- Diversification of product – reduces the risk of dependence on one product or service.
- Diversification of market – reduces dependence on one economy and on set of customers.
- Market power – increased power in the market allows firms to influence prices and to obtain better margins through reduced competition.
- Risk reduction – larger firms are less likely to suffer in market downturns and are less likely to be taken over by competitors.
10.7 In an increasingly competitive market, businesses are pressured into continually reducing costs and improving efficiency. One way of achieving this is to expand. Many large and successful firms have had modest origins. A.W. Thompson must ensure that they are continually monitoring these considerations, and this new order addresses a number of these.
11. External Environment
11.1 The economic environment
The external environment will have a large influence on the operations of A.W. Thompson. For example, during a recession, the construction industry is often hit the first and the hardest, as it is primarily income elastic.
11.2 The trade cycle shows the level of economic activity over time.
Recent figures for estimated GDP growth are shown in the table below.
11.3 In periods of growth A.W. Thompson will respond in a variety of ways, depending on the income elasticity of demand for the service.
11.4 Elasticity measures the responsiveness of the demand for a product following a change in a variable. Virtually, all businesses will experience greater opportunities for increased sales, profits and expansion during periods of economic growth. The impact of growth and the rising consumer incomes associated with it will not however have an even affect. It will depend on the income elasticity of demand on the business.
11.5 The following table will determine how income elastic the demand for A.W. Thompson’s service is.
(% Change in GDP figures from British Economy Survey, YPS)
11.6 The average income elasticity of demand for A.W. Thompson is therefore calculated as 3.45. This shows that the demand is highly income elastic.
11.7 As he produces a service which is income elastic, in times of growth, demand will increase significantly. For example, an insignificant increase in the average income in the UK will bring about a significant increase in the demand for A.W. Thompson. This is because during times of growth, the average household income will also increase.
Income elasticity of demand = % Change in demand
% Change in average income
11.8 Therefore, if the business is at full capacity, in the short run it should raise its prices, and in the long run it must invest more capital for possible development and expansion. This increase in sales revenue might result in greater profit, the possibility of marketing and further investment through ‘plough back.’
11.9 During a recession, two or more quarters of negative GDP growth, the prime objective of A.W. Thompson will turn to survival. The firms mark-up and therefore profits will decrease, and capacity will be under-utilised. The business may experience cash-flow difficulties. Looking at the cash flow forecasts and liquidity ratio, it is unlikely that this will be a problem. However, their debtors may find it difficult to repay debts or in the worst circumstances may go bust, thus limiting A.W. Thompson’s ability to pay its own debts and therefore threaten the survival.
11.10 It is therefore important that A.W. Thompson maximises its output during periods of economic growth, to compensate for a decrease in demand in times of economic decline. However, it is also important to remember that the government will attempt to influence economic activity through schemes such as fiscal policy: control of taxation and government expenditure, and monetary policy: the manipulation of interest rates by the Bank of England. It can be seen consequently, although as stated before the trade cycle occurs in a cycle, although a recession can not be prevented, the government will try to disrupt the cycle in order to create a stable environment, and therefore the cycle should only be used as a prediction for A.W. Thompson’s activities.
11.11 Seasonal factors should also be taken into consideration, as these also have an affect on the demand for the service A.W. Thompson offers. It can be identified from the cash-flow forecasts that A.W. Thompson’s activities are higher during the months of January and February, and the period from June to August. The same theory should be applied to the seasonal cycle as the trade cycle.
11.12 Gardiner & Theobald, the largest Quantity Surveying practice in the UK, have been consulted with regard to the prospects for the construction industry. This industry is one of the most sensitive to cyclical changes and they have revised downwards their forecasts for new construction projects. This is despite the forecasts of continued (though modest) economic growth.
11.13 A.W. Thompson might be well advised to accept the new order since other work might dry up.
9. SWOT Analysis
This is the assessment of a product, division, or organisation in terms of its strengths, weaknesses, opportunities and threats.
The strengths and weaknesses reflect the firm's current internal position, while the opportunities and threats represent future external possibilities.
9.1 Strengths
- Good reputation within the industry for overall quality, price and reliability. (Intangible asset)
- Well-established company.
- Large amount of goodwill with large public limited company- UNITE. (Intangible asset)
- Regular, reliable business, accruing the benefits of brand/customer loyalty. (Intangible asset)
- Is able to rely on word of mouth as main source of advertising and therefore has no overheads associated with marketing.
- Has low labour turnover with regular labour working for the business on a meet demand basis.
9.2 Weaknesses
- Although there are clearly 'untapped' markets for the business, the owner does not appear to have taken the opportunities of advertising, in that marketing and advertising strategies are undeveloped and limited.
- The owner's unwillingness to adopt new strategies in order to extend and develop the business.
- Low flexibility due to the management situation.
9.3 Opportunities
- There are few businesses in the market specialising as greatly as A.W. Thompson in the building industry. A.W. Thompson should therefore aim to benefit from offering a service to a niche market. A niche market is where a market segment is found, to which a business can adapt its marketing mix very closely, and in which there are few competitors.
- There is sufficient demand in the industry for A.W. Thompson to expand.
9.4 Threats
-
A downturn in the UK economy is a likely possibility due to recent outbreaks on a global scale. The recession is likely to hit small businesses like A.W.Thompson. Moreover, the building industry is often the one which is hit first hardest. However, the owner set up just as the longest and deepest recession since the war was about to hit. Therefore if he was able to set up successfully during this period, it is likely that he would not be detrimentally affected if a recession were to occur. Also, the most recent forecasts suggest that unlike Europe and the United States does not look as if it is set to go into a recession. (See the external environment above.)
- There is always the potential for new entrants into the market. A.W. Thompson should particularly be aware of and business' which may be possible sub-contractors for UNITE. As the industry can easily be entered on a small scale, there are limited barriers to entry.
- Loss of goodwill if Edinburgh job is not undertaken. Although this value is not shown in the balance sheet is can bee seen by the following amended Balance Sheet the position A.W. Thompson would be in.
12. Options
Rejecting contract
12.1 At present the company has a large amount of goodwill associated with the larger company UNITE supplying the majority of their business. Although this value has not yet been represented on the balance sheet. Although at present this has no significance to the owner, if at a later date it was decided to sell the business, the sale price would not value this goodwill. It would be a considerable threat to the company if this were to be lost as the company gives A.W. Thompson the majority of its jobs.
12.2 Through rejecting the contract for the job in Edinburgh for the various reasons outlined, UNITE would be forced to find new sub-contractors to take on the job instead. Although, as A.W. Thompson is currently working to full capacity this is not a short term problem, with profit at its possible highest for the set capacity, it may mean the possible loss of the long term goodwill UNITE offers the business. However, the geographical distance from Edinburgh might be acceptable to UNITE as in the accommodation and travelling would add to costs and so they might be better off finding a local sub-contractor anyway.
Accepting Contract see
See cash flow above
12.3 At present the only constraint to taking on extra business is the management situation. There is only one manager (the owner), therefore at one period of time this manager must be able to visit all sites of the jobs on a regular basis and deal with all the background activity required.
12.4 All other factors such as labour and materials are variable costs and can be employed according to demand. Therefore A.W. Thompson must look into hiring an additional employee on a managerial basis in order to increase the flexibility and capacity of the business. The disadvantages to this would be the loss of control of the owner, as he would have to rely and trust upon the new manager heavily. There is also the opportunity cost concerned with the time and capital spent on selecting, recruiting and training.
12.5 The major additional cost would be the increase in fixed costs in the form of a salary. It is unlikely that the one extra job will be able to compensate. However, the expansion needs to be long run, and income in the future needs to be forecasted and the risk assessed in different forms of investment appraisals.
Sub-contracting
12.6 By sub-contracting, that is finding another supplier to offer the same service, A.W. Thompson will be able to accept the job from UNITE and not risk losing the continuing goodwill. However, it is important to note that the sub-contractors would have to be heavily monitored in order to ensure they were of the same high quality that A.W. Thompson offers.
12.7 Also, there is an additional cost involved with sub-contracting, as not only would A.W. Thompson have to provide the same low quotation to UNITE as in the past, but also provide a mark-up to the sub-contractors in order for them to accept the job.
Expanding
12.8 Expansion is a long-term option for A.W. Thompson and one which could either be highly positive or extremely detrimental to the business in the future. Although, expansion in the short-term will only significantly increase turnover, it should lead to greater profits in the long run. This will however only arise in the future if there is significant effective demand (that is notional demand backed up by purchasing power) to supply A.W. Thompson with the demand to fill their increased capacity.
12.9 In order for expansion to occur, A.W. Thompson will have to find additional sources of capital to fund the increase in fixed costs. (See Sources of Capital)
13. Additional Sources of Capital
13.1 In order to fund the expansion should it be undertaken, A.W. Thompson will need to investigate sources of finance.
13.2 Internal Sources
- Extraction of cash from current assets
- Shareholders (although this is not possible with A.W. Thompson as it is not a public limited company.
13.3 External Sources
- Owner’s capital – Mr. Thompson could inject some of his own private wealth for the investment. However, there is a degree of risk in doing in so as the capital will then be tied up in the working capital of the business, and it will not be easily obtainable and should the business become insolvent, the capital would not be returned.
- Loan from the bank – As A.W. Thompson have no long term loans, the gearing is zero (gearing measures that proportion of capital employed that has been raised through borrowing), and as A.W. Thompson has a very stable and prospering financial position (see cash flow forecast, profit and loss account and balance sheet.), the bank may be inclined to give A.W. Thompson a loan for the investment. The main disadvantage of obtaining a long-term loan is the interest that has to be paid on the loan. However, there is also a high risk associated with taking out a long-term loan, as A.W. Thompson is a sole trader. As a sole trader, Mr. Thompson has sole responsibilities for his debts. This means that should the business fail, and there is insufficient money to pay the debts, the owner can be declared bankrupt through legal processes. All the property of the business (in this case none) and the personal property of the owner will then be sold to pay the debts and, should the money realised by the sale prove to be insufficient for this purpose, the court will have claim on the income of the owner until all the debts have been paid. This is because as a sole trader, the owner has unlimited liability for the debts and behaviour of the business.
15. Critical Path Analysis
In the early part of the 20th Century, HL Gantt used a chart system which showed time-relationships between ‘events’ in a production programme. He recognised that total programme goals should be regarded as a series of interrelated plans that could be followed more easily. Because of this, the critical path method was developed in 1957, in order to improve the planning, scheduling, and co-ordination of new plans. The critical path is the sequence of key activities that determine the time needed to complete an activity.
Critical path network for expansion of A.W. Henderson
16. Critical Path Network Analysis
16.1 It can be seen from the critical path network that taking on the additional job will take a total of seven weeks. This is useful to know as it enables A.W. Thompson to give an accurate finishing date of the job to UNITE, and also enables the accurate employment of labour.
Calculating the earliest start time for each activity allows the manager to order any special equipment or materials needed for that task, at the correct time, in advance.
16.2 Calculating the latest finishing time if each activity is also a useful control tool. The manager will be able to see whether the project is on schedule by checking the actual completion times of activities against the network’s latest finish time.
16.3 Knowing the critical path is essential. If there is a delay on a critical activity such as recruiting and training a new manager, there is no float time because it is critical and the delay will, unless quick action is taken, put back the whole project beyond the seven week objective.
16.4 It also allows greater flexibility with the allocation of resources. For example, if the activity of recruiting and training a manager is taking longer than the expected three weeks, the manager can transfer resources from assessing the future demand for the service, and estimating the cost for the future as this task has a float time of 1 5/7 weeks. This will therefore allow a better and more efficient use of the firm’s resources.
17. Estimated payments and receipts for potential job
These were gathered in order to investigate the contribution the job would make to break-even, and therefore whether the additional job should be taken on. The extra costs and receipts can be seen on 7.5, the cash flow forecast including the additional job.
Estimated Costs
East Lothian skip hire 1260.00
Basic partition systems 18360.00
Pickington Glass 7220.00
Artistic Blinds 1840.00
Laidlaw 620.00
Muraspec 800.00
Don Rice Labour 13400.00
Total 75600.00
Gross Margin 11100.00
Selling Price 86700.00
Receipts
Quotation
Unite Integrated Solutions plc.
103 Temple Street,
Bristol BS1 6EN
Re. 15-16 Abercromby Place, Edinburgh
To: Supply and install relocatable partitioning 86700.00
Vat 17.5% 15172.50
101872.5
18. The recruitment of a manager
18.1 The personnel/human resource management department of an organisation normally carries out the job of the recruitment of people in an organisation. However, as A.W. Thompson is a relatively small business, it does not have this facility. As the job of a manager is a high position, it would be advised that the owner of the business has a considerable input in the recruitment process.
18.2 The steps in the recruitment process are:
- Job analysis – The objectives of an organisation are subdivided into a series of separate specialist tasks or jobs. The purpose of job analysis is to produce a job description or job specification, which defines the main characteristics of a job.
- Provide details of the job/job specification – The job analysis should provide sufficient information to compile details of the skills and knowledge that the job requires. These details normally specify the craft, mental, and the decision skills required.
- Advertise the job/recruit employees - Most employees are recruited from outside the organisation from the following sources: Press advertisements, government agencies, job centres, private agencies, further and higher education, and direct employment.
- Interview and select the applicants – Interviewing is the most widely used method of assessing people. Although psychology tests and assessments centres are also used. Normally, an organisation will draw up a short list of those candidates whose skill and knowledge are closest to the job specification.
- Appoint the candidate – The appointment of a person is a contract between the employer and the employee: the employer makes the offer of the job and the employee accepts the offer in writing. The contract of employment is a legal agreement between the employer and the employee. It describes the duties and responsibilities of the post held by the employee, and states the pay and conditions of the work including working hours and holiday entitlement. The employer can terminate the contract if the employee does not fulfil the duties.
19. Break-even Analysis
19.1 The break-even point is the point at which total costs are equal to total revenue. Break-even analysis can be undertaken in two ways:
- The graphical method
- The equation method
19.2 The break-even equation: A formula can be used to calculate break even:
Where contribution = total revenue – variable costs
The margin of safety is defined as the number by which sales exceed the break-even point. This is a useful indication of how much sales could fall without the firm falling into a loss.
In addition to obtaining break-even points and margins of safety, break-even charts can also be used to demonstrate the impact of different options on the operations of a business. It can therefore be used to show the impact of taking on the additional job. However, it should only be used as a guide as there are some major drawbacks associated with break-even analysis. It makes the assumption that costs and revenues are expressed in straight lines; not all costs can be reliably or consistently classified as fixed or variable costs; and it is based on the assumption that everything produced will be sold.
Accounts of which the analysis is based
Fixed costs at present – 375,000
Total Variable costs at present – 40,000
Total revenue at present – 450,000
Fixed costs with additional job – 397,000
Total Variable costs with additional job – 115,600
Total revenue with additional job – 551,872.50
When taking on the additional job the fixed costs will increase an estimated £22,000 – the cost of employing an additional managerial employee. The total variable costs will increase by £75,600 to cover the overheads shown in the estimated costs for potential job. The increase of £101,872.50 is the increased revenue received from UNITE on completion of the job.
It can be seen from the break even chart that even with the increase in fixed costs, at no point of output would the business incur a loss, with total costs being greater than total revenue for that unit of output.
Contribution
In order to assess whether the additional job in Edinburgh should be taken on, the contribution it would make to fixed costs/profit should be calculated. The contribution is calculated using the following formula:
Therefore, the total contribution for the additional job =
£101,872.50 – £75,600 = £26,272.50 contribution to fixed costs.
This would be a very useful tool if the firm had spare capacity, when deciding whether to accept a new order, because as long as the new job would create sufficient revenue to cover the variable costs associated with the added output, and make a positive contribution to fixed costs.
However, in the case of A.W. Thompson, the additional job not only means an increase to the firm’s total variable costs, but also an increase to their fixed costs of £22,000.
Therefore, although the additional job makes a positive contribution of £26,272.50 to fixed costs, as the fixed costs increase by £22,000, the total profit raised would only increase by a smaller proportion than at first thought of £4,272.50.
Conclusion
In conclusion, judging by the information obtained from the owner of A.W. Thompson, and the prospects of the construction industry for the future, it is recommended that the additional job in Edinburgh is undertaken, by employing an additional manager.
It can be seen from the cash flow forecast that it would primarily increase the businesses cash flow position by an estimated £61,372.50. However, other benefits include the maintenance of the goodwill and the loyalty of the larger company, UNITE providing added security for the future and providing an added £50,000 on the balance sheet in terms of an increase of fixed, intangible assets.
It can be seen from the breakeven analysis as well, that the risk associated with taking on the extra job is minimal, as at no point with the additional job does total costs exceed total revenue, even though fixed costs actually exceed by £22,000. The added fixed costs are that in order to cope with the extra capacity by taking on an additional manager, needed to take on the additional job. This not only allows A.W. Thompson to accept the contract, but also increases their flexibility and capacity generally for the future.
The only doubt however with this strategy, is the fact it has not been done before and the business has no experience of hiring staff at such a high level. The quality of the new staff is therefore a vital component as to whether the additional job will be a success. There is no certainty, and therefore the owner may still be reluctant to take on the job, even though the majority of evidence suggests it should be taken on.
However, it can be seen that it might be essential to the business to take on the job because as suggested in “The External Environment”, if the economy takes a downturn, the effects A.W. Thompson will be highly detrimental. The service and products A.W. Thompson offers are of an income elastic nature as found by previous back-data. This means that although the estimated GDP growth for 2002 only decreases by 0.3%, it is estimated that it will bring about a 1.035% decrease in sales. Therefore, while A.W. Thompson has the chance, it should increase its revenue, so it will be able to compensate for the possible decrease in sales for the projected year.
